The Daily Interview: Clash of the Media Titans

Trying to keep track of the recent alliances between the major music companies and their online challengers can leave one head's spinning.

John CorcoranInternet and Digital New Media Analyst,CIBC World Markets

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First, AOL Time Warner ( AOL), EMI and Bertelsmann's BMG Entertainment announced a partnership with RealNetworks ( RNWK) to roll out an online music subscription service as early as this summer, to be called MusicNet.

A few days later, Yahoo! ( YHOO) announced it would be featuring the competing Duet subscription service developed by the other two major record labels, Vivendi Universal's ( V) Universal Music Group and Sony's ( SNE) Sony Music Entertainment, on its site.

Subsequently, Universal announced it was acquiring online music sites MP3.com ( MPPP) and Emusic.com ( EMUS) for $372 million and $24 million, respectively. Such alliances would have been unimaginable a year or two ago, considering the major recording labels' antagonistic stance against the upstarts of digital music delivery.

John Corcoran, the Internet and new media analyst at CIBC World Markets, sees further industry shakeout and power shifts in the future, including between behemoths such as AOL Time Warner and Microsoft ( MSFT).

TSC: How does Universal's acquisition of MP3.com and Emusic fit into its strategy in the digital music industry? How does this move fit into its alliance with Yahoo! and Sony to deliver music over the Internet?

Corcoran: The music world is undergoing significant change as major players brace for the transition to the online distribution and consumption of music. Right now, these players are scrambling to acquire the assets and infrastructure necessary to participate in the expected growth of online music. An example of this is Universal's acquisition of MP3.com and eMusic. In doing so, Universal is acquiring the technology and customer-facing services that will enable it to make Duet a viable competitor to MusicNet, whose support and back-end services are provided by RealNetworks.

Such deal-making is likely to continue apace in the near term. On Monday, as a matter of fact, EMI announced a deal with Roxio ( ROXI), which will make EMI's music easier to download over the Internet. We are also getting an early indication that Napster may be near a deal with MusicNet to leverage MusicNet's offerings and support. There will be additional scrambling for the assets, infrastructures and personnel necessary to make online music a reality. So there will be more movement of the pieces on the chessboard in the near term.

TSC: Will Vivendi Universal be able to mount a viable challenge against AOL and its already formidable ability to reach U.S. consumers on multiple platforms?

Corcoran: AOL will wind up on top when it comes to distributing music over the Internet. Universal will also be a large player, but AOL will be able to extract the maximum economic rents of all the players in this area. Stepping back a bit, MusicNet, of which AOL and Warner Music are a part, is more advanced than Duet at this point. Both services will launch this summer but neither will sell directly to consumers.

This means that Yahoo!, RealNetworks and AOL and a host of others will offer the online subscriptions to consumers using the support and back-end services of either MusicNet and Duet. AOL has a significant advantage over other players in this area, because it can leverage its music offering across more than 32 million AOL and Compuserve subscribers. Remember that AOL will roll out open access this summer and it will have a broadband pipe into the home over its own cable infrastructure, and eventually over other operators' infrastructures, which will give yet more of an advantage.

In addition, AOL can advertise its music offering over its multiple media platforms, and AOL is the master of cross-marketing and cross-promotion. That doesn't mean that Universal, Yahoo! and Sony won't have big roles to play through Duet. Universal and Sony are the number one and number two record labels, respectively, so you know they're interested in maintaining their relative positions on the Internet as well. But the question is how much of a head start MusicNet has over Duet, and how well Universal and Sony will be able to coordinate their efforts to integrate the assets they have just acquired, such as MP3.com and Emusic.com.

TSC: Napster's explosive popularity stemmed from its ease of use and broad access. Would you agree that these are the key factors of success?

Corcoran: Absolutely yes. At the end of the day, consumers will not and cannot figure out what label produced the content they want to hear or buy. What they can do is identify the artist or song. Just as when you go to a Blockbuster ( BBI) store, where you can get all the movies from all the major studios, online music players will have to come up with an offering where almost all of the content from major labels is available in a variety of areas across the Internet.

As there are many Blockbuster locations in any major city, you need a number of locations for the music as well. Also, the lesson of Blockbuster movie rentals teaches us that most rentals of the content focus on new stuff and even a small subset of the new stuff. That is how I think online music will likely develop, with a big focus on new music, but also a need for all the content to be available on many sites.

TSC: How is the landscape of the media industry evolving? How are the dynamics among major players changing?

Corcoran: Music is quite an important part of the overall strategy for major media and entertainment players. It's a hits-driven business, which means that the performance of any company in any particular quarter is difficult to predict. But it is a $40 billion industry every year, and there will be dramatic changes in the industry, as the online distribution and consumption of music accelerates. Online music really takes cost out of the system; the Internet is a highly efficient form of content distribution.

In the last two years, the major players have focused on suing and shutting down Napster and MP3.com, instead of figuring out how to jump into the online music space as quickly and profitably as possible. So what they're doing now is playing a bit of catch-up.

As for some of the major changes going on in the industry landscape, one interesting topics is the readjustment of the relationship between Microsoft and AOL. The overarching theme for these mega-players is "Don't get stuck as a dial-up to the desktop." By that, I mean these two players are positioning themselves to provide services to a variety of access devices over multiple infrastructures.

More specifically, Microsoft is moving from a software business model to a services-based model. It is also branching out into a number of new directions: Most notably, in the interactive TV space, there's its Ultimate TV offering, and in the gaming area, there is its Xbox offering. Interestingly, AOL is doing precisely the same thing: It has an interactive TV initiative called AOL TV. And two weeks ago, it announced a gaming initiative with Sony's PlayStation 2. It's also heavily moving into the music area, with its MusicNet initiative.

Microsoft and AOL have an unusual and uncomfortable balance of cooperation and competition going on. They compete in a number of areas such as portals, dial-up ISPs and in the browser area, as well as in instant messaging, email platforms and online music. But they also cooperate in a number of areas as well. AOL, for instance, chooses Internet Explorer as its default browser, while Microsoft allows easy access from its desktop to AOL services. Both of these companies are in the process of renegotiating and readjusting their relationship.

For someone like me, it's fun to watch because this is not only the battle of titans but the battle of well-funded titans. So it is not yet clear how they're going to adjust their relationship. AOL is considering different options on the browser front. It may open its doors to different choices. The bottom line is we do not yet know how the symbiosis will take new shape.

TSC: How can investors make money in this sector? What catalysts in the near term exist for your picks?

Corcoran: Our overall theme remains the same: From the investors' perspective, it's always smart to stick with quality names, the best management teams and the companies with the soundest strategy. Our picks in the large-cap area are AOL and Gemstar-TV Guide ( GMST). On the small-cap front, we like WebEx ( WEBX).

AOL has a number of catalysts from which it should benefit in the near term. There is its 9% price hike in its dial-up service starting in July, which affects about 20.7 million subscribers in the U.S. Besides the online music offering, the company will also be able to offer its ISP service over other operators' pipes as well, which will be great for AOL's business.

Gemstar has a couple of catalysts as well: Its interactive program guide (IPG) is a major catalyst for the company and supports about 60% of the company's valuation. Additional long-term IPG licenses with major cable and satellite operators will be a major catalyst for the stock. In addition, the expansion of the IPG platform into international markets will be important, and of course the consummation of the merger between Sky Global and DirecTV, if it happens, will prove to be a catalyst.

WebEx is a small-cap company in the enhanced Internet communications area. It's a leading provider of high-end Web collaboration. It will benefit from additional customer announcements and strong quarterly results in the second and third quarters as the company marches towards breakeven in operating income, which we expect will happen in the fourth quarter of this year. And obviously, a strengthening in overall economy and high tech industry will help this company.